BitLendingClub (not to be confused with Lending Club) has shut down their bitcoin-based p2p lending platform, citing regulatory pressure. A message posted on their website says, “over the last year or so, the regulatory pressures has been increasing to the point that it is no longer feasible to maintain the operation of the platform. We are regretfully announcing that we will have to begin terminating the services effective immediately.”
BitLendingClub received a $200,000 seed investment from European VC fund LAUNCHub just two years ago. The company changed its name to LoanBase in September 2015 but then changed it back only a few months ago.
This was no small experiment either. Kiril Gantchev, BitLendingClub’s CEO, claims on his LinkedIn profile that the company made more than 10,000 loans worth more than $8 million dollars, originating from 90 countries. The company’s website claims an average APR of 192% and a default rate of nearly 12%.
In March however, the company stopped lending to people in several countries including Iran, Ireland and Nigeria due to elevated fraudulent activity.
It’s unclear what “regulatory pressures” caused them to shut down but the company appears to have been operating from San Francisco despite originally incorporating in Bulgaria. A search for a California lending license connected to them yielded no results. After the US, the country with the 2nd most borrowers on the platform was Venezuela followed by Brazil, the UK and India.
“Investors should understand the risks involved when making bitcoin loans,” their website warned. “The main risks are default and failure to collect.” they added.
Thanks to the Ezubao ponzi scheme that opened up a can of worms and sent a slew of Chinese P2P lenders packing, the government is considering placing caps on the P2P lending sector to protect investors.
As part of the crackdown on Chinese P2P lenders, the central bank began collecting data on the process of assessing risk and deploying capital for loans made online after authorities arrested executives from two other Shanghai-based wealth management firms in May.
As per the new proposed cap, an individual investor can only provide loans upto RMB200,000 (US $30,000) on one lending platform, and cannot lend more than RMB1 million (US $150,000) in total.
Chinese media reported that over 515 P2P platforms have shut down in the first half of the year, with fraud being a pervasive reason. Despite problems, China continues to have the largest p2p lending sector in the world.
In South Korea, the government isn’t sure if Funda is a direct funder. Funda, ironically spelled like the New York pronunciation of the word, is one of several companies offering high yields to investors across their peer-to-peer lending marketplace. The average rate of return is 10.94%, according to Funda’s home page.
But according to Bloomberg, the government isn’t positive if investor money being poured into the industry is really being used to fund loans. Not that any company is accused of wrongdoing at this time, rather the Financial Services Commission is attempting to get out in front to prevent problems from occurring in the first place.
In China, for example, the government’s willingness to remain hands-off and let p2p lending blossom, resulted in catrastrophic levels of fraud and mismanagement. By May, ratings agency Moody’s reported that 800 Chinese platforms had already failed or were facing liquidity issues. Even worse, more than $10 billion of investor money was ensnared in Ponzi schemes. An astounding 900,000 individual investors lost money in the Ezubao fraud alone.
The Korean market is still relatively new. According to the The Korea Economic Daily, there were only 20 p2p lenders in the country as of the end of March. South Korea is home to more than 50 million people, about 15% the size of the US.
The concern around online lending is global.
As a part of the crackdown on Chinese P2P lenders, the central bank is collecting data on the process of assessing risk and deploying capital for loans made online. The rapid expansion of new players and the subsequent fraud cases that followed, forced the government to take control.
Last week, (May 16th), Chinese authorities arrested Xu Qin, owner of Shanghai-based wealth management firm, Wealthroll Asset Management Co. who confessed that his company still owed 5.2 billion yuan ($797 million) to 12,800 investors. And before that, in April the police arrested 21 executives of Shanghai-based Zhongjin Capital Management, that promised retail investors double-digit returns for short-term projects.
The can of worms was opened with the shakeup of Ezubao, the Chinese P2P lending site which duped 900,000 investors out of $7.6 billion in February this year. Following which, the Chinese police were ordered to shut down illegal online lending sites and take swift action against suspects.
The Ministry of Public Security also launched an online platform in a quest to garner more information from the public and warned of P2P lender defaults in June, when payments will be due.
The crackdown of newfangled finance firms that emerged from the ashes of the Ezubao ponzi scheme opened up a can of worms.
And the latest head to roll is of Xu Qin, owner of Shanghai-based wealth management firm, Wealthroll Asset Management Co. who confessed to the authorities that his company still owed 5.2 billion yuan ($797 million) to 12,800 investors. Qin and 34 other executives from the firm were arrested on May 13th.
Qin who started the firm in 2011 with an initial investment of 5 million yuan from friends and family allegedly misused investor money on homes, luxury cars and on buying high-end office spaces for the firm in Shanghai.
This emerges in the wake of the shakedown of Ezubao, the Chinese P2P lending site which duped 900,000 investors of $7.6 billion in February this year. Following which, the Chinese police were ordered to shut down illegal online lending sites and take swift action against suspects.
The Ministry of Public Security also launched an online platform in a quest to garner more information from the public and warned of P2P lender defaults in June, when payments will be due.
The country’s banking regulator, China Banking Regulatory Commission (CBRC) and insurance regulator had also alerted the risks associated with investing in these schemes and barred these lenders from raising funds and signaled that close to 1,000 such businesses accounting for 30 percent of the industry could go belly up.
The Ezubao scam that surfaced on February 3rd revealed that 266 executives of Chinese P2P companies had fled and gone into hiding in the last six months. Ratings agency Moody’s has said that 800 platforms have already failed or were recently facing liquidity issues.
“We have so many fans but we also have some people here that are looking to take advantage of us, that are here for a short term trade and they won’t be part of this industry.” – Ron Suber, President of Prosper Marketplace
Ron Suber may have been talking about specific players in the capital markets when he said those words at LendIt just a few weeks ago but that characterization could just as easily apply to all of Wall Street in general. During his presentation, he offered two real world examples about how their message got hijacked by the same facilitators they originally believed were there to help them. The first was a case of bad buyers.
“When a marketplace lender sells a bunch of loans and the buyer isn’t aligned with the marketplace, if the buyer of those loans is going to buy those loans and leverage them, rate them, and securitize them every single quarter without alignment with the industry and just sell those bonds into the marketplace, […] that won’t be good for you, for the industry,” he said. “And we learned that lesson. When we don’t have alignment with our investors, when groups sell our loans into the market no matter what if the market’s not ready, it’s not good and we learned that at Prosper this year.”
What he was saying is that the buyer matters because if they’re repackaging up the product for mass consumption, it is ultimately the original seller (i.e. companies like Prosper) that is being judged for the success or failures of the product’s reception down the line.
A second example stemmed from mismatched projections. You might think it’d be a good thing if a rating agency’s own analysis of your loan portfolio projected even lower loss rates than you projected on your own. Not so, and this actually happened; Moody’s projected loss rates for the loans packaged inside of Citigroup-issued Prosper bonds were lower than what Prosper projected itself for the same vintage. So when default rates were on pace to exceed Moody’s aggressive projections (and fall in line with Prosper’s), news of an impending bond downgrade due to allegedly poor performance roiled the market. The media interpreted Moody’s adjustment to mean that something was wrong with Prosper, not that something was wrong with Moody’s initial assessment.
Suber summed these experiences up by telling the audience, “we must control our story.” That’s a challenge because Wall Street loves to commoditize things, especially loans. The value goes up, the value goes down, and Wall Street will sell it if there is a buyer for it without any regard for the story. What to do then?
CommonBond CEO David Klein said on a panel in late March that marketplace lenders will look to tap back into individual investors, that there will be a return to the industry’s peer-to-peer roots.
Fundera CEO Jared Hecht, a co-panelist, said that “retail investors are more loyal to a specific platform” and that this can create a “network effect.”
The problem of course with retail investors, aside from the steep regulatory hurdles to sell to them, is the comparably slow speed at which they allow a platform to scale. The downside for any company that takes this organic approach is that they could grow so slowly that they get eclipsed by everyone else.
But perhaps the underlying issue is that some companies that originally set out to be peer-to-peer lenders have succumbed to this identity of being “online lenders.” That’s a problem because traditional financial institutions can use technology to lend online too and the Internet will eventually become the standard medium for all lending. That means that soon being an online lender will just mean being a lender period. And if you are just a lender, well then Wall Street will indeed take advantage, control the story and charge their standard fare just for playing the game.
The price? One soul.
And once you sell yours, it’s hard to get it back.
Google will kill its prepaid debit card this June to re purpose it as a P2P payments app.
Wallet Card, which was launched in November 2013 lets users make payments at ATMs, banks and any business that accepts MasterCard Debit.
The project faced multiple roadblocks from the start when it was leaked way back in November 2012, shelved plans in May 2013 before its subsequent launch later that year.
As Android Pay is becoming Google’s mainstay for in-app purchases and third party payments, it makes little sense to continue two similar products. The company is referring Wallet users to American Express and online bank Simple by offering a sign up bonus.
“After careful consideration, we’ve decided that we’ll no longer support the Wallet Card as of June 30. Moving forward, we want to focus on making it easier than ever to send and receive money with the Google Wallet app”
Last month (February 23) Google shut down its financial products comparison tool, Compare.
Institutional investors wanted higher yields on Prosper’s latest bond offering, an entire five percentage points higher, according to the WSJ. This wasn’t necessarily brought on by performance either. Instead the once voracious appetite for all things online lending is being tempered by uncertainty.
Bain Capital Ventures partner Matt Harris told the WSJ that online lenders will need to replace the easy hedge fund money by “longer-term capital.” Normally, that would include traditional bank lines and credit facilities, but moving that direction could irreversibly sever the ties with their peer-to-peer roots and image.
Peer-to-peer (p2p) lenders embraced Wall Street’s easy money to scale, rationalizing to the peers on which they were founded that this was all necessary to change the status quo. The road to the sharing economy utopia required hobnobbing with the very institutions they were set on disrupting, they said. The P2p term wasn’t compatible with this narrative so it was replaced with “marketplace lending,” which helped it retain its Silicon Valley feel and gave it the range to argue that hedge funds and peers were virtually the same thing since they were both buyers in a new-age marketplace.
But early this year, something started to happen. Loan originators like SoFi (which was never peer-to-peer) could not sell loans fast enough. One solution they came up with was to launch their own hedge fund to buy their own loans. SoFi CEO Mike Cagney said, “In normal environments, we wouldn’t have brought a deal into the market, but we have to lend. This is the problem with our space.”
But blaming financial institutions for pulling back credit is a scenario that has played out thousands of times in history. One only need watch The Big Short to connect why it’s dangerous for a lender to depend on the institutional credit markets. That’s where the peer-to-peer model was supposed to come in, a new way for a new day without Wall Street to prevent these problems.
But it’s not too late to go back. Lending Club for example, has capped their wholesale channel (the institutional portion) at 50%. They’ve kept more than 100,000 retail investors and intend to grow that even larger. “We’ve always been more exposed to retail, and I think we want to keep it that way,” said Lending Club CEO Renaud Laplanche to the Financial Times. “We’ll probably see that as a competitive advantage, as a source of stability and predictability, particularly in an economic downturn,” he added.
Prosper meanwhile has depended almost entirely on the institutional channel, an astounding 92% of their loans were sold to that category of investors. It’s a far cry from the slogan that appeared on their website back in 2007. “People-to-people lending. It’s an old idea that’s new again,” it said. Today it says, “We connect people looking to borrow money with investors.” Those investors are predominantly Wall Street.
But what to do when Wall Street will one day no longer be interested? It’s not too late to go back in time.
“Borrow money from people just like you,” said Prosper’s website nine years ago. People just like you might not suddenly decide they want five percentage points more. Peer-to-Peer implied a human aspect to the marketplace, that empathy played a role in a world where Wall Street had always been stone cold.
Will the industry revert back to the people? Or will ideas such as starting your own hedge fund to buy your own loans rule the day?
P2P lending platforms will increasingly rely on larger hedge funds to fund their expansion, The New York Hedge Fund Roundtable believes.
The Roundtable is a non-profit organization committed to promoting education and best practices in the hedge fund industry. Timothy P. Selby, the organization’s president, said of a recent study they conducted, that institutional investors can’t afford to ignore Peer-to-Peer (P2P) lending. “Investing in peer to peer loans not only means the promise of high risk-adjusted returns, such private debt investments also provide less correlated risk relative to more traditional fixed income portfolios,” he said.
And as P2P platforms expand and need money, hedge funds feel it is they that will have the leverage in the negotiations.
In a survey of their members, 21% of respondents chose Lending Club as the business they believe best represents the future of banking 10 years from now. 11% picked Capital One. 6% chose Facebook.
Yet only 17% of respondents had actually actually invested in P2P lending so far. Part of the hesitation comes from the present state of interest rates. 20% of respondents believe that institutional capital will move away from P2P lending and back into traditional finance once interest rates start to really increase.
In the meantime, increasing interest in P2P lending by institutional investors will lead to riskier loans, they say, and it could lead to another credit crisis.
Credit crisis? What Credit crisis?
78% of respondents said history has proven that investors have incredibly short memories and that if securitizations backed by P2P loans offer attractive returns investors will likely dive in.
Of the survey respondents, 24% were fund managers; 9% were allocators; 9% were risk management or trading; 46% were service providers; and 12% were other industry participants.
Consumers can now borrow up to $40,000, an increase from the previous cap of $35,000.
The new maximum should raise eyebrows. That’s because while one of Lending Club’s biggest allures is the ability to refinance credit cards into a lower rate over a fixed term, there are zero safeguards in place to ensure that the borrower actually uses the proceeds to do just that. Instead, the applicant simply checks a box and if approved, gets the loan minus the origination fee wired to their bank account. That means today’s consumer can obtain 40 grand in one lump sum online. Unsecured. In their bank account. For whatever purpose. From a lending marketplace that puts none of their own money in the loans.
No Recessionary Data for Loans Over $25,000
The numbers look okay, for now. Using NSR’s backtesting tool revealed that loans of exactly $35,000 have generated higher returns for investors than loans of smaller sizes, but have a higher loss rate. This is because the interest rate increases with loan size. The all time loss rate on $35,000 loans is 6.60%, according to the tool, but Lending Club didn’t start making loans this big until February 2011, after the recession had already ended.
That in itself should be alarming because when we examine the time period of June 2007 through June 2010, when the Great Recession occurred, loss rates hit the largest loans the hardest. At that time, the maximum loan size was $25,000 and the loss rate on those was 11.54%.
With the maximum size having increased to $35,000 and now to $40,000, there is no recessionary data to indicate how these large loans will perform.
The Temptations of a Cash Windfall?
Credit cards can moderate spending habits because there is a limit on the type of goods and services one can acquire with them. With cash, consumers may be tempted to indulge themselves in other things. One has to wonder if the average consumer really needs 40 grand wired to their account on an unsecured basis with no strings attached on what to do with it.
Lending Club might have considered this already though. In December, they announced Direct Pay, a pilot program in which Lending Club actually requires borrowers to use up to 80% of the proceeds to pay off their outstanding debt. There’s one caveat, it’s only open to a category of the most risky borrowers, those with Debt-to-Income (DTI) ratios of up to 50%. Lending Club’s traditional DTI cap is 30%.
That means that investors have to rely on the ability of borrowers to do the right thing with 40 grand in unsecured cash. Should they trust them?
It’s a “belt and suspenders” precaution according to Lending Club CEO Renaud Laplanche. The Madden v Midland case has forced the company to rethink their arrangement with WebBank, the chartered bank that allows them to make loans nationwide. Under the new terms, the fee LendingClub pays to WebBank for the loans it issues will be related to how the loans perform over time.
Even if the U.S. Supreme Court were to rule unfavorably in Madden, Lending Club would still have been able to operate freely under their old arrangement. The change then may be a response to several cases, including ones that have accused online lenders of using chartered bank relationships to carry out alleged abuses. According to law firm Ballard Spahr, a “federal court refused to dismiss Pennsylvania racketeering claims against companies alleged to have partnered with a state bank to market Internet loans illustrates the risks inherent in these relationships and the importance of proper structuring.”
In a brief, Ballard Spahr wrote:
In Commonwealth of Pennsylvania v. Think Finance, Inc., et al., the Pennsylvania AG, working with a well-known private plaintiffs’ firm, claimed that the companies and their individual principal had engaged in a “rent-a-bank” scheme in which a Delaware state bank “acted as the nominal lender while the non-bank entity was the de facto lender—marketing, funding and collecting the loan.”
By WebBank maintaining an interest in the outcome of the individual loans, Lending Club will reduce its potential standing as the de factor lender.
Notably, the breaking story focused on Lending Club. WebBank also has a relationship with others in the alternative finance community such as CAN Capital, Prosper, AvantCredit and PayPal. It’s uncertain if their arrangements will also be subject to change.
“Effective today, Prosper has increased its estimated loss rates and the price charged for risk on the loans originated through the platform,” said an email to investors on Monday. “We believe this move ensures that our borrower payment dependent note and whole loan products remain competitive for our investors in the current turbulent market environment that we have witnessed since the beginning of 2016.”
Prosper is one of only two marketplace lending platforms in the US that is open to retail investors. Founded in 2005, the company has made over $5 billion in loans. They were surpassed by Lending Club in the race to dominate the market after being nearly destroyed by both the Great Recession and a class action lawsuit that claimed they sold unqualified and unregistered securities in violation of the California and federal securities laws. The suit was settled in 2013.
The going forward rate increase affects one category of high risk borrowers by as much as 199 basis points. Meanwhile, even prime borrowers will experience increases of up to 29 basis points.
These are the changes according to Prosper:
Estimated Aggregate Impact to Prosper Portfolio of Loss and Price Changes
Proposed Pricing Modifications for the Week of 2/15
Last week, the company also refaced their entire site. As a Prosper investor, the new user interface greatly improves the user experience.
Lending Club’s retail investors scored big on February 12th when they announced an integration with TurboTax software. The complexity of marketplace lending from a tax perspective has historically been one of the most prohibitive cost barriers for retail investors. Unlike savings accounts which issue a standard 1099-INT, Lending Club (and Prosper) issue both a 1099-OID and a 1099-B.
According to the IRS, the 1099-OID should “state the excess of an obligation’s stated redemption price at maturity over its issue price. Original Issue Discount (OID) on a taxable obligation is taxable as interest over the life of the obligation. If you are the holder of a taxable OID obligation, generally you must include an amount of OID in your gross income each year you hold the obligation.”
For the average person, explanations like these are enough to warrant the help of an accountant. But that’s a problem for people that are investing a small amount. For example, if $10,000 invested in Lending Club notes generated $700 in income for the year, it wouldn’t be practical to pay an accountant $500 to help you figure it all out. Between that and the actual taxes owed, an investor could easily end up losing money.
Lending Club tries to make it all as easy as possible for investors with their step-by-step tax guide, but it can still feel a little confusing. One problem to consider is that investors can only deduct up to $3,000 of their losses if they don’t have any other capital gains.
While an integration with TurboTax is a win for retail investors, marketplace lending had long been a thorn in the side for TurboTax. Complaints about the software not being “peer-to-peer friendly” have haunted Intuit’s help pages for years.
Real estate lending platform Patch of Land announced that it signed a $250 million agreement with an east coast based credit fund to purchase its loans in a forward flow arrangement.
The reluctance to name the city or state of the fund suggests that in doing so would too easily reveal who it is.
Patch, an LA-based lender which uses a data-driven underwriting model, promises investors a risk adjusted return with extensive available data to support the underlying credit decision on each loan.
The company founded in 2013 had raised a million in seed funding and $125,000 in debt in 2014, followed by $23 million in Series A funding last year. And it has funded more than 200 projects, with an average blended rate of return to investors of 12 percent
This is continued evidence of institutional interest in loans generated by marketplace lenders. JP Morgan Chase bought loans worth a billion dollars from Santander Consumer USA Holdings Inc earlier this month. The bank also partnered with OnDeck in December of last year to facilitate the underwriting of the bank’s small dollar small business loan program.
In an interview with Bloomberg, Funding Circle’s CEO Sam Hodges said that it’s the first of many such partnerships to come where big banks will realize the potential of fast-growing fintech startups.
Wants to buyback shares for $150 million.
Online lending marketplace Lending Club earned $4.3 million in profits in Q4 last year and facilitated loans worth $8.4 billion to small businesses and consumers in 2015.
The San Francisco-based P2P lender’s revenue grew in Q4 grew by 93 percent to $134.5 million compared to $69.6 million in the comparable period a year ago. Loan originations also grew to $2.58 billion from $1.41 billion in 2014.
The company, which was the first P2P lender to register its offerings as securities with the SEC is gung ho about its growth prospects. “We have earned the trust of 1.4 million customers,” said founder and CEO Renaud Laplanche. “We have considerable room to grow our existing products, and intend to continue to expand both our product line and addressable population going forward.”
The company which announced that it will also buyback shares worth $150 million through open market operations or in private transactions in compliance with Securities and Exchange Act Rule 10b-18.
This comes amidst doubts raised about the company’s algorithm-based lending model. A Bloomberg report last week questioned Lending Club models with data to show that its actual defaults (7 to 8 percent) were higher than forecasts (4 to 6 percent). The company responded to the report explaining the data and reassuring investors that the loan performance is within expectations.
This week I surpassed more than 500 lifetime early note payoffs on Lending Club. Considering that loans on the platform are either for a fixed term of 36 months or 60 months, I was quite surprised to see that the average early payoff was happening just 10 months in. My portfolio is too young for even the first loans I ever bought to have reached maturity so the data isn’t entirely statistically relevant. But to put what I’ve experienced so far in perspective, out of every note I’ve ever bought on this platform up to and including today, 17% of them have already paid back early in full.
One borrower paid back their 3-year loan in just 8 days!
Of the 145 5-year notes I bought just 20 months ago in May 2014, 36% of them have already paid back in full. This is astounding, but apparently old news. A PeerCube analysis conducted two years ago revealed that 80.6% of all fully paid loans were pre-paid in full before reaching maturity.
At face value, these statistics could be used to boost investor confidence. The loans are so affordable that just look at how many people are paying off early! But according to Anil Gupta at PeerCube, these borrowers might not be paying these loans off at all. Lending Club might be refinancing the loans with a new loan, which cashes out the original investors early in the process. As said in his analysis:
A PeerCube user who is also a borrower on Lending Club mentioned that he has been receiving requests from Lending Club to refinance his loan. Such offers are very attractive to borrowers whose FICO score may have gone up since taking the first loan. In this case, the second loan may come with lower interest rate due to improved credit score. Moreover, there is no deterrent in the form of pre-payment penalty for borrowers to refinance the loan. Lending Club benefits from a borrower refinancing an existing loan by charging additional origination fee from the second loan, i.e. more revenue.
Lending Club’s website says that to be eligible for a second loan, borrowers have to have made 12 months of successful, on-time payments on their existing Lending Club loan. “Sometimes,” however, they “identify customers who are eligible for an additional loan before those 12 months and ask them to apply.” That’s the policy for having two active loans at once, not for refinances specifically.
Lending Club’s quarterly earnings reports make no clear mention of repeat borrowers and there’s no way for an investor to know if the debt consolidation loans they’re taking risks in are really just refinances of existing Lending Club loans. But even if they were, that wouldn’t necessarily make them a bad thing.
Would you rather invest in a borrower who has already proved 12 months of positive payment history OR somebody brand new? But then again, would you rather invest in a refinance of a loan that was originally taken to refinance a credit card?
There’s a downside to loans being paid off early. If an equal reinvestment opportunity does not exist to immediately replace the paid off loan, then the investor loses. If they are no longer reinvesting anyway, then an early payoff deprives the investor of the interest to offset future chargeoffs from the remaining loans that will go bad. And worse yet, investors are forced to pay a penalty to Lending Club for any loan that pays off early after the first 12 months in the form of a 1% fee on all outstanding principal. Seriously, investors are penalized for early payoffs for which they have no control over and are not allowed to know why or how the borrower paid off earlier.
Sounds very weird to me…
The market has turned overwhelmingly bearish on tech-based lending companies lately, but no company has perhaps felt the brunt more than Yirendai, a Chinese company listed on the New York Stock Exchange. Since their IPO less than two months ago, the price has already dropped by more than 60%. Investors seem to be basing that judgment on one thing, the general fear of that business model in China.
And who can blame them? Only a week ago, Ezubao, one of China’s largest peer-to-peer lenders, was revealed to be a $7.6 billion Ponzi scheme. More than 900,000 investors were impacted. The CEOs of more than 250 similar companies there are in hiding after experiencing failures of their own.
On February 3rd, Yirendai announced a framework agreement with China Zheshang Bank Co., Ltd and CreditEase Pucheng.
“I am pleased to announce the cooperation between Yirendai and Zheshang Bank in the field of microloan lending and consumer finance,” said Ning Tang, Yirendai’s Executive Chairman. “This cooperation illustrates Zheshang Bank’s recognition of our strong online operation capabilities. It will provide the opportunity for individual borrowers to receive lower cost funding. ”
The news fell flat and the stock dipped down that day. The company closed at $3.83 yesterday, a new all-time low on no news.
Marketplace lending is one of this year’s hottest buzzwords but its meaning is not very intuitive. According to a recent Federal Deposit Insurance Corporation (FDIC) report, “marketplace lending is broadly defined to include any practice of pairing borrowers and lenders through the use of an online platform without a traditional bank intermediary.” This might sound similar to peer-to-peer lending and that’s because it’s the same thing, the FDIC explains. “Although the model, originally started as a ‘peer-to-peer’ concept for individuals to lend to one another, the market has evolved as more institutional investors have become interested in funding the activity. As such, the term ‘peer-to-peer lending’ has become less descriptive of the business model and current references to the activity generally use the term ‘marketplace lending.'”
Voilà, marketplace lending is what you get when peers are replaced by private equity firms, pension funds, and hedge funds. Additionally, there is a general assumption that the intermediary platform is also underwriting and grading the loans.
The FDIC separates marketplace lenders into two categories, the “direct funding model” and “bank partnership model,” both of which are illustrated below:
In both circumstances, investors are actually buying securities, rather than participating in the loans themselves.
The FDIC says that marketplace lending can encompass unsecured consumer loans, debt consolidation loans, auto loans, purchase financing, education financing, real estate loans, merchant cash advance, medical patient financing, and small business loans.
For even more information, read the official report.
What if all the notes you bought on a peer-to-peer or marketplace lending platform were tied to loans that didn’t exist?
Such a scenario has not only happened but is a recurring theme over in China. The recent $7.6 billion fraud that was allegedly perpetrated by the management of Ezubao (a Chinese-based P2P lender) affected more investors than Bernie Madoff. Approximately 900,000 investors were impacted, according to CNBC.
But it gets worse, way worse. If you can believe this, the bosses of 266 other Chinese peer-to-peer lenders have fled and are in hiding. And that’s just in the last six months. Ratings agency Moody’s has said that 800 platforms have already failed or were recently facing liquidity issues.
In the case of Ezubao, there’s little doubt about what happened. Company executive Zhang Min told Xinhua news agency, “Ezubao is a Ponzi scheme.”
Lend Academy’s Peter Renton, who has witnessed the peer-to-peer lending industry in China firsthand wrote in his blog today that it’s too easy to start a platform there. “You need just US$1,000 to create a smartphone app, then obtain a very inexpensive business telephone license and you can be up and running,” he wrote.
Unsurprisingly, another Chinese peer-to-peer lender that just recently joined the New York Stock exchange, Yirendai (NYSE: YRD), was collateral damage to the Ezubao bombshell. Shares of the company dropped nearly 21% Tuesday to $4.88, down more than 50% from their IPO price.
Does the threat exist in the US?
Here at home, industry insiders are hardly worrying about China. “Could this level of fraud happen in the US?” Renton asked in his blog. “I think it is highly unlikely. There is a well-developed ecosystem in the US for both consumer and small business credit and appropriate lending licenses need to be obtained in most states before a company can begin operations.”
Renton is partially right. Most of the well-known platforms in the US are operating under watchful eyes. But there is a surging over-the-counter (OTC) marketplace that most outside investors don’t even know exists. Enter the syndication market where commercial finance brokers and investors can co-invest in loans or merchant cash advances through private marketplaces that may or may not have a website. With alluring yields of up to 100% a year or even more, it’s the perfect environment to pull off a scam if one maliciously intended to do so. [note: most are not scams at all]
The OTC market for these investments rely almost entirely on trust. There is little to no transparency into how investor funds are actually used. deBanked has received tips over the last twelve months that some companies have co-mingled investor funds with operational cash flow, with the result sometimes being a total loss of investment. Several lawsuits have been filed against these alleged fraudsters, deBanked has discovered, but none compare to the scope of damages taking place in China.
The last major Ponzi scheme to grip the commercial side of the industry for instance, involved Agape Merchant Advance (AMA), a Long Island based company that was part of a wider fraud conducted by sister company Agape World Inc. According to the 2012 complaint, “the defendants actually ran a Ponzi scheme, paying returns to Agape and AMA investors not from any profits earned on investments, but rather from existing investors’ deposits or money paid by new investors.”
In a report published by the FBI that explained how it worked, they wrote, “the defendants received an e-mail from Agape’s loan underwriter informing them that the interest rate that a bridge loan borrower had agreed to pay Agape was only 16 percent for one year, at the same time the defendants had promised to pay their investors 12 percent for 60 days for this investment, or 73 percent for the year. The defendants raised approximately $32.5 million for this bridge loan, although the loan was never made.”
The fraud, carried out mainly by its chief executive Nicholas Cosmo, was captivating enough to earn it a spot on CNBC’s American Greed series.
At the time Agape was operating, such yields should’ve raised an immediate red flag for investors, at least that’s the moral the TV show tried to communicate to viewers. In the real world today, those yields could be considered too low since actual commercial bridge financing transactions can pay out up to 40% over 90 days. And therein lies the danger. When legitimate deals are transacting for incredible premiums, how do you resist considering an investment?
It’s easy to chalk up China’s peer-to-peer lending fraud woes to China being China. But the pervasiveness and ease with which such scams have been carried out should send a strong message to marketplaces in the US.
Do you trust where your money is going? Are they using it exactly how they said they will?
Next on American Greed…
After Santander Consumer USA Holdings Inc. [NYSE: SC] announced they were trying (almost desperately it seemed) to shed $1 billion worth of Lending Club [NYSE: LC] loans from their balance sheet, investors weren’t sure if was the loans themselves that were a problem or if there was something else going on.
Santander CEO Jason Kulas said back in October that, “although the personal lending portfolio is performing well, we no longer intend to hold these assets for investment.” The rationale was that they would refocus their efforts on subprime auto lending. The market didn’t take the news well and rewarded Santander by gutting the share price from $22.10 on October 28th down to $10.10 by February 1st.
In a report put out last week by Chris Donat, a company analyst at Sandler O’Neill & Partners, it was intimated that the Lending Club loans Santander was still holding may have contributed to the fourth-quarter loss of $232 million that they reported last week on its unsecured personal loan portfolio. “In light of the damage that the personal loan portfolio inflicted on Santander’s income statement in 4Q15, we will be relieved when Santander is out of this business,” Donat wrote.
But fears of possible toxic Lending Club loans subsided on Monday when the WSJ announced that JP Morgan Chase was acquiring Santander’s portfolio and at a “premium.” The average FICO score of those loans is reportedly around 700. “The sale was being closely watched by credit markets as an indicator of the health of the market for online personal loans,” the WSJ said.
Lending Club’s share price closed up 3.12% on the news, but is still stuck near its all time low.